Tokyo-Osaka Seen as Best Bet After Deals Fail: Real M&A

By Toshiro Hasegawa and Jason Clenfield -
Mar 26, 2012

As stock exchange mergers crumbled
from Frankfurt and New York to Singapore and Sydney, traders
have become only more convinced that Japan’s plan to combine its
biggest bourses is the best bet to succeed.

Shares of Osaka Securities Exchange Co. (8697), the smaller of the
two main venues in the world’s second-largest equity market, are
trading about 3 percent lower than the 480,000 yen offer from
Tokyo Stock Exchange Group Inc., according to data compiled by
Bloomberg. With the operator of the Toronto Stock Exchange
valued at 12 percent less than its own pending takeover bid,
arbitragers who profit from acquisitions are signaling that
Japan’s merger is the more likely of the two remaining bourse
deals to be completed, the data show.

While regulators and politicians in Brussels, Washington
and Canberra helped scuttle $32 billion of exchange takeovers in
the past year, Japan’s need to revive its standing as a
financial hub ensures the TSE-Osaka deal will be approved,
according to JPMorgan Chase & Co., as the government looks to
create a “comprehensive exchange” that unifies Japan’s nine
bourses. The country’s Financial Services Agency was involved in
discussions between TSE and Osaka before the deal was announced,
according to two people with direct knowledge of the talks.

“There’s a tremendous amount of pressure to get this
merger done,” Jonathan Foster, Singapore-based director of
Global Special Situations at Religare Capital Markets Plc, said
in a telephone interview. “The whole of the government wants to
encourage the merger.”

Edo Period

Eight months after TSE president Atsushi Saito said he was
planning to hold merger discussions with Osaka, the companies on
Nov. 22 announced an agreement that would combine Tokyo’s
dominant position in equities with Osaka’s derivatives platform.
The deal valued Osaka at 129.6 billion yen ($1.6 billion).

The exchanges described the merger as “a step toward the
revitalization of the Japanese economy,” and said the tie-up
would save 7 billion yen in annual costs by integrating computer
systems, according to the deal announcement.

Shares of Osaka fell 500 yen, or 0.1 percent, to 464,500
yen today.

Two Steps

The transaction will be conducted in two steps, with TSE
first bidding for as much as 67 percent of Osaka in a tender
offer. Once that purchase is complete, Osaka’s shares will be
swapped for those of the unlisted TSE, so the new exchange
remains publicly traded. The companies project the acquisition
will close in January.

The TSE-Osaka announcement brought the total of proposed
exchange acquisitions since October 2010 to almost $40 billion
as venues from Asia to North America tried to cut costs and
offset declining profits from equity trading with options,
futures and derivatives. None of the deals have been completed,
with at least four derailed by opposition from regulators,
politicians or shareholders.

‘Really Different’

Frankfurt-based Deutsche Boerse AG (DB1)’s bid to buy NYSE
Euronext and create the biggest exchange operator was rejected
last month by European Union regulators who said the deal would
hurt competition by creating a “near-monopoly” in derivatives.

The wave of failed merger deals hasn’t shaken the
confidence of traders in the TSE-Osaka tie-up. Osaka’s shares
reached a high of 465,500 yen last month even after the Deutsche
Boerse-NYSE deal collapsed, and closed last week 3.2 percent
below TSE’s offer.

“What’s really different about this deal compared with the
other exchange mergers” that failed is that it involves one
country, Sachin Shah, a Jersey City, New Jersey-based special
situations and merger arbitrage strategist at Tullett Prebon
Plc, said in a phone interview. “It seems like they’ve been in
contact with the government to see how this would go over and
it’s looking pretty good.”

‘National Champion’

Putting the country’s top bourses together has been a
priority for Japan’s government since at least June 2010. The
ruling Democratic Party of Japan that month announced an
economic growth strategy that called for restoring the country’s
position as Asia’s top financial hub by 2020 and laid the
groundwork to create an exchange that combines the nation’s
derivatives and commodity markets in one entity by 2013.

Japan’s cabinet this month submitted legislation that will
give the Financial Services Agency oversight of stock,
commodity, and grain exchanges, a step that will make it easier
to eventually combine the markets. Regulation is currently
divided between the FSA and the trade and agriculture
ministries.

“This is about building a national champion,” said Jesper Koll, head of equity research at JPMorgan in Tokyo. “The big
driver is the Financial Services Agency.”

Japan’s securities regulator participated in monthly
discussions about the TSE-Osaka deal with representative of both
exchanges, according to two people with direct knowledge of the
talks, who asked not be identified because the discussions were
private. Ryutaro Hatanaka, the FSA’s top bureaucrat, held a
meeting with TSE president Saito and Osaka president Michio Yoneda around the end of October, one of the people said.

Nikkei’s Slump

The government didn’t push for the merger, spokesmen for
the bourses said last week. The exchanges met with the FSA only
to update them on the deal’s progress, said Kazuhiko Yoshimatsu,
a spokesman at TSE. There wasn’t any assistance from the
government, according to Osaka spokesman Masahiro Yada.

Officials at the FSA weren’t immediately available to
comment on the nature of the regulator’s role in the merger.

Japan’s standing as a financial center has declined as the
Nikkei 225 average posted the biggest slump among major stock
indexes since the end of the 1980s and China overtook the
country as the second-largest equities market in 2008.

While Japan has since regained its lead over mainland
China, more than five times as many shares are now traded in
Hong Kong than in Tokyo. Japan’s main exchange also held less
than 1 percent of the world’s initial public offerings last
year, data compiled by Bloomberg show.

Following up the TSE-Osaka merger with acquisitions of
Tokyo Commodity Exchange, which deals in metals and oil, and the
Tokyo Grain Exchange could add 2 billion yen a year to operating
profit for the new company, Stephen Barker, a Credit Suisse
Group AG analyst in Tokyo, wrote in a report on Feb. 21.

A merger is also a prerequisite to any expansion outside of
Japan to close the gap with rivals in Asia, according to Fukoku
Capital Management Inc.’s Yuuki Sakurai. Average daily volume in
Hong Kong almost doubled in the five years through 2011 to 12
billion shares, while the number of shares changing hands in
Tokyo rose by only 8 percent, according to the exchanges.

‘Capable of Negotiating’

“We may have much more tie-ups with Asian stock
exchanges,” Sakurai, chief executive officer at Fukoku Capital,
which oversees $7.4 billion in Tokyo, said in a phone interview.
“To do those deals you must have one combined exchange which is
capable of negotiating with exchanges in other regions.”

The combined exchange’s potential is one reason the current
share price “appears to underestimate the value of the company
that will result from the planned merger,” Credit Suisse’s
Barker wrote. Osaka is worth 500,000 yen per share, he said.

“Osaka has a strong derivatives trading business and,
compared with equities trading, derivatives is growing faster,”
said Ichiro Takamatsu, who helps oversee $2 billion at Bayview
Asset Management Co. in Tokyo. “That’s one of the reasons that
some investors are saying the bid price was too cheap.”

The number of options and futures contracts traded on the
Osaka exchange more than tripled to 194.1 million last year from
60.6 million in 2006, data from the bourse shows. Equity trading
in Tokyo grew less than 10 percent in the period.

‘Blow it Up’

Saito and Yoneda have both said the deal price won’t be
changed. Osaka’s shareholders, the largest of which are overseas
funds, will have an opportunity to raise the issue in June, at
the annual shareholder meeting.

Traders remain confident the deal will close. Osaka’s
shares finished last week about 0.1 percent below their highest
level since a magnitude-9 earthquake and tsunami struck Japan a
year ago, leaving 19,000 people dead or missing and triggering
the world’s worst nuclear disaster in a quarter century.

By contrast, shares of Toronto-based TMX (X) are trading 12
percent below a C$50-a-share takeover offer valued at C$3.73
billion ($3.7 billion) from 13 Canadian banks and pension funds
known as Maple Group Acquisition Corp. Canada’s competition
watchdog has said it has “serious concerns” about combining
TMX, the operator of the Toronto Stock Exchange, with Alpha
Group and Canadian Depository for Securities Ltd. as part of the
deal to create an entity that would control most of the
country’s trading and clear all its transactions.

In Canada, “I am not sure that all of the regulators and
public sentiment is fully behind the transaction,” Larry Tabb,
chief executive officer of research firm Tabb Group LLC in New
York, said in an e-mail. In Japan, “the government is behind
this as well as both exchanges and there is no one outside of
the deal that is looking to possibly blow it up,” he said.